Leading business development company, or BDC, Main Street Capital (NYSE:MAIN) investors have done well since the bottom from the massive fear-induced selloff that led to a capitulation in mid-October 2022. Based on a total return basis, MAIN has outperformed the S&P 500 (SP500) since my initial article in September last year.
Notwithstanding the relative outperformance, MAIN suffered a steep pullback after topping out at the $43 level in early August. That resistance level is hardly surprising, as it also led to a steep pullback in March, as investors fled due to the regional banking crisis earlier this year.
Despite that, I don’t expect MAIN to fall back toward its March lows, as I have confidence that we are not expected to suffer a debilitating hard landing. Economists have also become increasingly optimistic that we could avoid such a pitfall. Fed Chair Jerome Powell’s recent address at the Jackson Hole symposium also didn’t suggest that we could face such severe economic stress in the near term. As such, MAIN dip buyers who avoided the doom and gloom calls in October 2022 and March 2023 have been well-rewarded as they focused on the company’s solid business fundamentals.
Keen investors should be aware of the company’s increased focus on the lower middle market or LMM segment. It’s exposed through a diverse portfolio of debt and equity instruments. Main Street Capital is also expanding its private loan segment as it moves to reduce the portfolio exposure of equity-linked instruments for its middle market segment.
The company’s second-quarter or FQ2 earnings scorecard demonstrated the robustness of its strategies, as it delivered a record net investment income or NII per share of $1.06. Notably, the surge in interest income was instrumental in the earnings performance, with “40% of the increase from the prior quarter is attributed to benchmark index rate increases.” In addition, investment conditions have improved further, allowing Main Street Capital to bolster its debt investments, which helped drive its NII per share outperformance.
Despite that, it’s also crucial for MAIN investors to note that the critical driving force through benchmark rate increases could slow down and stall moving ahead. Powell’s speech at the recent symposium highlighted that while the Fed’s job isn’t considered over, the FOMC could be more cautious in future rate hikes if incoming data doesn’t support it. As such, it’s prudent to assume that earnings outperformance could become more challenging as compared to what Main Street Capital has capitalized.
Analysts’ estimates suggest that Main Street Capital’s NII per share could have peaked in Q2 and could likely reverse through H1’24, reaching $0.97. However, I don’t assess imminent risks to its dividend structure, as the quarterly payout ratio from NII for H1’24 is expected to remain in the 80% zone.
As such, buying sentiments at significant dips are expected to remain robust, as MAIN last traded at a forward dividend yield of 7.6%. It’s slightly ahead of its 10Y average of 7%, suggesting investors have likely discounted the potential sequential decline in NII per share moving ahead.
From a price action perspective, MAIN has moved back into a medium-term uptrend, auguring well for investors looking to buy dips.
I assessed that MAIN buyers must robustly hold the $37 levels for the uptrend continuation price action to follow through. Dip buyers have attempted to hold the recent August lows at the $39 level, but the bottoming process has not been validated.
Hence, investors looking to add exposure can consider spreading their purchases across these two possible buy levels to help improve their risk/reward. However, investors should abstain from adding close to the $43 resistance zone until it has been decisively breached subsequently.
While Main Street Capital could suffer earnings headwinds over the next four quarters as the interest rate tailwinds subside, its valuation remains attractive. Coupled with constructive price action, investors can consider buying significant dips, such as the one we experienced in August. As the price action isn’t optimal, keeping spare ammo to average down could prove helpful to improve their risk/reward profile.
Rating: Upgraded to Buy. Please note that a Buy rating is equivalent to a Bullish or Market Outperform rating.
Important note: Investors are reminded to do their due diligence and not rely on the information provided as financial advice. Please always apply independent thinking and note that the rating is not intended to time a specific entry/exit at the point of writing unless otherwise specified.
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